Understanding ERC 1559 and its significance
Since its inception, the Ethereum blockchain has come a long way. However, there is no denying that some parts of this technology are still riddled with a few flaws. One such part is the Ethereum monetary policy.
Current Ethereum Fee Model
In simpler terms, the current fee model of Ethereum is nothing but a simple auction mechanism, i.e., first-price auction. In other words, if you want your transactions to be selected by the miner, just pay higher gas fees. Yes, it’s that simple.
However, if observed rigorously, this simplicity in the fee model actually leads to some very concerning as well as undesirable scenarios.
This first price auction mechanism results in a very inadequate as the miners simply filter the incoming transactions on the basis of high to low prices. This procedure technically leads to a scenario where the users end up paying excessively for their transactions
Eric Conner, who was one of the authors behind EIP 1559 shared very interesting data that clearly depicts how users grossly overpay by more than 5x to get their transactions mined.
Additionally, when it comes to wallets, for instance, Metamask, this fee model makes it incredibly troublesome for wallets to accurately anticipate the fees that should be paid for a particular transaction.
Enters EIP 1559
One can never deny that in the present era, the longevity of any technology is, more often than not, subject to the evolution and improvements of its functional and operational aspects.
EIP 1559 can be understood as one of the imperative improvement proposals that quite effectively addresses the issues in the current fee model.Before understanding the significance of EIP 1559, let’s first have a brief glance at the working mechanism of this proposal:
- To begin with, EIP 1559 includes 2 major concepts:
- BASE FEE.
- Elasticity of the Block Capacity
Base Fee can simply be understood as the minimum fees that must be paid by the users to get their transaction included in the block.
Quite interestingly, this base is adjustable. It means the base fee depends on the congestion in the Ethereum network. Higher the congestion, the higher the Base Fee.
On the other hand, the elasticity of the blocks allows the miners to create further blocks with a comparatively larger capacity. For instance, changing the maximum limit of gas from 12.5M to 25M gas, in the time of high demand in the network.
Now, if the demand continues to be high, the miner would keep producing blocks with utmost capacity but also increase the Base Fee with every new block.
The subsequent increase in the base fee plays a significant role because the high price will drive away some of the users and gradually reduce the demand. Once the congestion in the network is lowered, the Base Fee goes down as well.
Qucik Question: What if the miners themselves boost the Base Fee to earn more profits?
Well, EIP 1559 solves this issue quite effectively.
In order to prevent any such scenario, the entire Base fee in this fee model is simply burnt. The miners only receive the miner tip.
Significance and Merits of EIP 1559
- Reduction in transaction costs: EIP 1559 quite effectively reduces the transaction costs up to 90%.
- Prevention from Fee Manipulation: This proposal eradicates any possibility of manipulation of the base fee since the BASE FEE IS ALWAYS BURNT and is received by NO ONE.
- Burning BASE FEE is Profitable for Users: In case you haven’t noticed yet, Burning the BASE FEE is actually making ETH more valuable. This is because a higher demand in the network means higher BASE FEE which ultimately leads to a higher number of ETH being burnt. This excessive burning of ETH reduces the supply of ETH, thus increasing its price or demand.
- Mitigation of the Wait Time: The increase in the Block capacity at the time of extreme congestion in the network technically leads to more transactions being mined. This enhances the user experience even at the time of high network demand.5.Fees can now be accurately anticipated by the Wallets: Unlike the traditional fee model of Ethereum, EIP 1559 plays a remarkable role by enabling the wallets to easily predict the fee for the users. Since the rise or fall of the block size is effectively constrained, the base fee can quite easily be calculated. It allows the wallets to predict an accurate base fee by simply observing the data received from the previous blocks.
Parts of this series:
- Flash loan attack explained | Part1 | DeFi: In & Out
- Impermanent losses explained | Part2 | DeFi: In & Out
- Role and significance of Governance in Defi | Part3 | DeFi: In & Out
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